That Smell

Listen to Lynard Skynard and you know that smell is quite an ambiguous term. Read The Perfume by Patrick Suskind and you know that having extraordinaire smell capabilities can be deadly. Read the guest contribution of former IMF staffer Peter Doyle and you learn that the IMF and its projections for a primary budget surplus are exactly that -smelly! He put together IMF calculations for primary budget surpluses for Italy, Spain, Ireland, Portugal and Greece that are required in order] to achive public budget sustainability until 2018. Those figures were published in the World Economic Outlook publications between April 2013 and April 2015. Three things stick out. First, Greece is not a one-of-a-kind case in regards to primary surplus demands; the required surplus for Italy with 5.5 % was even calculated higher then the 4.5% surplus the IMF calculates for Greece. Second, the calculations were actually going up and down in brief time, only in case of Greece the IMF held course. Most recently, in April 2015, the IMF moved up the requirements for Greece from 4.2% to 4.3% – a small increase but one that actually corresponds nicely to some budget reductions the IMF asked for in exchange for further credit support. Third, those calculations may not smell as strong as Doyle insinuates but, for a minimum,they come with a strong dose of ambiuity that makes one wonder how hard the figures exactly are. That may be to some degree unavoidable but it is a problem when at the same time those figures are used in negotiations as hard facts.

It seems to me that the closer we come to the Greek endgame the less facts are playing a critical role in the discussions. Spin is what is needed in order to create a winning narrative. Karl Whelan (https:/medium.com/bull-market) gave a convincing reply to the factless FT op-ed of Francesco Giavazzi. The Gavazzi piece could be seen as totally irrelevant if it would not be a part of the narrativ austerians are eager to launch. Spin is not only about substituting facts by ideoliogy but also about interpreting facts in a way that makes them irrelavant. Moreover, spin is about producing arguments that shows the future in the best interested way. The current spin of the day(s) is to generate a discussion where Greece’s returns to a national currency is seen as a promising second-best option. Indeed, the idea that Greece as well as the Eurozone would be better off if Greece leaves is getting more and more public support, in Greece as well as in Eurozone economies. According to a most recent representative poll in Germany, a majority now favours a Greek exit and also thinks that this is the best option for Greece as well as for the Eurozone.

So far such sentiments have not led to a bank run of Greek savers. However, this may happen soon if the negotiations break down and the formal deadline for a compromise is passed. Until today private deposits in Greek banks are steadily shrinking, and Greek banks may meet soon a tipping point where further withdrawals would undermine their minimum deposits. For the moment, Emergency Liquidity Assistance (ELA) provided by the ECB keeps Greek banks swimming but this tool is restricted and not meant at all to deal with a bank run. A bank run can easily turn into capital flight. Capital controls would be the first action of the Greek government to prevent such a turn of events. This would be no new action in the Eurozone – Cyprus did exactly that before, and still is a member of the Eurozone. Like in Cyprus, though, capital controls would not be welcomed by everybody, and may add to the level of discontent a GREXIT would generate.

A default of Greece does not mean that the country is leaving the Eurozone, nor the EU. For some months, Greece could stay in the Eurozone but would no longer be eligible for emergency programs from the side of the Eurozone. Hence, the probability of the introduction of a new currency would increase with an GREXIT. This could happen as a parallel currency or as a stand-alone national currency. Such a new money would immediately get depreciated against the Euro and other currencies. As long as debt are denominated in Euro, this makes debt service to a huge problem as interest and principal would now to have financed by a weak currency. Critical sectors of the Greek economy would be unable to come up with adequate debt service und moce out of the market. Also, Greek would experience a steep rise of its inflation rate as imports would get quickly very expensive – given Greece’s import-dependence the price increase for goods and services from abroad would have a strong influence on the inflation rate. Simple textbook analysis provides the argument that the same depreciation would make Greek exports cheaper, and thus compensate the negative effects of depreciation, at least if we assume similar price elasticities for exports and imports. And yet, too much optimism seems to me misguiding as Greece has no strong export sector in terms of technological content or product quality. Hence, the improvement in price competitiveness would not induce an ‘export miracle’. The sector that would benefit most would be tourism – good enough in itself but probably not sufficient to compensate the negatives.

A steep increase in the inflation rate would shrink real purchasing power of wages and salaries, and thus weaken real effective demand. It would also strengthen incentives for informal economic activities and thus weaken state income. It is difficult to imagine that all this would not generate social unrest, and question the so-far good domestic standing of Syriza. In any case, GREXIT would come with high economic and social costs , and benefits would come, if at all, ionly at a later point in time. This discrepancy of timing must be scary for any government.

GREXIT is no moon walk for the Eurozone, either. The Eurozone has no regular default regime and thus a Greek default would require quite some improvisation on-the-go. In any case, Greek creditors would have to accept quite some losses. The true loser would the the common currency, though. What initially was meant to be a marriage for eternity would become a partnership of time. Members could come and go, more or less as they like. A common currency zone with a well-equipped institutional setting and a effective regime of governance can be seen as a insurance against the steady speculation fevers of financial markets. Partnerships of time are a different beast, and financial markets will test the waters, like they did successfully in the past. Those markets smell quickly if they see a chance to feast on the weak. Rather then making the Euro stronger, GREXIT actually would weaken the common currency.

All tghis is well known, and I trust that both sides draw the right conclusions and compromise in a way that leaves Greece breathing room. And yet, a compromise can be only a first step. There is a strong coinsent between economists from all camps that Greece needs a well-designed partial haircut in exchange for fundamental economic-political reforms, rtaher then simple supply-side reforms. This asks from the EU and the Eurozone to move beyond its neoliberal simplistic approach. This will not happen, and thus a compromise today about the last tranche of the second program would be nothing else then the prelude for the next act of the drama.